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A CONVERSATION WITH GEORGE SHULTZ By Tony Batman with Introduction by Art Laffer Posted: Feb 12, 2013

[George Shultz is one of the most respected individuals on the planet, having served as with great distinction as Secretary of Labor, Director of the Office of Management and Budget, Secretary of the Treasury, and Secretary of State. Educated at Princeton and MIT, he is currently a distinguished fellow the Hoover Institution at Stanford University. My friend Dr. Arthur Laffer sent me the following interview of Secretary Shultz by Tony Batman, founder of 1st Global. The piece begins with an introduction of Secretary Shultz by Art. Messrs. Laffer and Shultz have both given permission for me to post this on my website. I hope you get as much inspiration from it as I did.]

A CONVERSATION WITH GEORGE SHULTZ

ABL: As always, it’s a pleasure being with all of the 1st Global team. A short while ago I had a 1st Global conference call, and I think I may have left the impression that I am pessimistic about the future of both the American and world economies. Well, if the truth be known, while I think the next year or two is going to be tough I am not pessimistic about the long run. It is very true that we are faced with the unpleasant prospects of Taxmageddon and, believe me when I tell you, Taxmageddon is a very serious problem. But you already knew that. Tax rates are rising. In anticipation of higher tax rates in 2013, businesses and people have shifted income out of 2013 into 2012. Such a shift in income makes 2012 look a good deal better than it should—and in spite of looking better than it should, 2012’s income still looks awful—and the shift in income will also make 2013 look a lot worse than it should. Yikes!

People are also aware of the Federal Reserve’s aberrant behavior which contains a very real threat to our financial future. And then there are the problems in California. The election results both nationally as they pertain to California and the election results in California specifically—especially the tax increase—don’t bode well for our nation’s largest state. Sequestration is yet another problem for the long-term security of our nation. And, as if it hasn’t been in the news enough, we all are aware of the problems in Europe. These problems, however, are all, as Tony Batman says, “known problems”—problems you can plan on and problems that have already been partially discounted in the market.

And while there have been, as Waylon Jennings and Willie Nelson sing, “the bad times and bad things they’ve done,” if I may, to continue quoting Waylon Jennings and Willie Nelson, “let’s talk about the good times we’ve had and all the good times to come.” The image of the Phoenix rising out of the ashes of our past is apropos the current circumstances we find ourselves in. Out of all these predictably bad consequences of ill-conceived policies a lot of good will emerge. Remember, it did take Jimmy Carter to give us Ronald Reagan.

Stock prices today are unbelievably low relative to profits, interest rates and taxes, i.e. capitalized economic profits (Figure 1).

Figure 1
Capitalized Economic Profits vs. S&P 500 Index
(monthly, end of period, semi-log scale, Jan-70 to Jan-13)

fig1

[1] Arthur B. Laffer and Ford M. Scudder, “It Doesn’t Take a Nostradamus,” Laffer Associates, July 9, 2012.
[1] Waylon Jennings and Willie Nelson, “Good Hearted Woman,” Wanted: The Outlaws!, 1976.

 

In fact, stock prices are about the lowest they have been in the last forty years in relation to profits, interest rates and taxes. Bond yields have never been lower—especially yields on government bonds (Figure 2).

 

Figure 2
10-Year U.S. Treasury Bond Yield
(monthly, average of daily, Apr-53 to Dec-12)

fig2

 

 

I believe Tony Batman to be correct when he said there is going to be a blow-off in the bond market, and that bond blow-off will inure to the benefit of equities.

After the 2012 election, the national press created the impression that President Obama not only won the election in a landslide but that he also had a mandate. In truth, the election was a reinstatement of the status quo. President Obama did win, but he received 50.6% of the vote for his second term. Compare that result to Ronald Reagan’s 59% of the vote for his re-election. Harding and Coolidge, when they were elected in 1920, received 60% of the vote. Coolidge in 1924 defeated his Democrat opponent in a three-way race by over 25 percentage points and his Progressive opponent by over 37 percentage points. Ouch! Now that’s a mandate. The Obama victory of 2012 isn’t a rout and it surely isn’t a landslide. There is still a huge amount of dissension and discontent in the U.S.

As of today, the Republicans outnumber the Democrats 234 to 201 in the U.S. House of Representatives. Republicans picked up one governorship in this election and now have 30 governors to the Democrats’ 19 and one independent, Lincoln Chafee from Rhode Island. Even the Senate losses, as disappointing as they are, are far from a rout. In the best of times it’s hard for a Republican to win in a statewide race in Maine. When Republican Senator Olympia Snowe retired from office, it was a certainty that the Republicans would lose that seat. The election of Republican Senator Scott Brown in Massachusetts two years ago was a miracle in the first place. That he was even in the Senate is proof that God exists. And then there were the catastrophes in Missouri and Indiana. The Republican candidates in those two states, Akin and Mourdock, with their comments were able to throw away two virtually certain pick-ups for the Republicans. In truth, the Republicans lost four seats off the top in the Senate and yet only lost two seats on net.

I don’t think our current political environment is particularly bad contrary to what other people may say. Because of what I believe is going to happen to the U.S. economy, I wouldn’t want to be President Obama in 2013. 2012 simply wasn’t our year for the political change and economic revolution America so desperately needs. But our day will come. In 2014, there are 33 Senate seats up for election, 20 of which are currently held by Democrats, and 13 are held by Republicans. Of the 20 seats held by Democrats, nine of those Senators are first-termers who were elected in the Obama victory of 2008. So there’s a lot of opportunity for political change in the U.S. Senate in 2014. As I see it, I couldn’t be more excited about the future of the U.S.

Great things come to people who wait, and this just wasn’t our year to take over, but our year is coming. In the next four or five years there will be a huge political change in the U.S. You are going to see the U.S. adopt a low-rate flat tax. You’re going to see spending restraint—not in the next couple of years but surely in the next five years. One of the reasons why the U.S. economy has performed as “well” as it has is because of the huge drop in federal government spending as a share of GDP since the debacle of 2007-2010 (Figure 3). We still spend way too much, but that cut in spending from the peak has benefited the economy.

 

Figure 3
U.S. Federal Spending as a % of GDP
(quarterly, NIPA basis, 1Q-1990 to 3Q-2012)

fig3

 

The U.S. will return to fiscal solvency and show restraint in spending. A low-rate flat tax, spending restraint, sound money—I know that sounds really impossible in today’s world, but let me tell you, we can return to prosperity and there is a realistic good path back to reestablishing a sound dollar. That will happen. Today’s political economy isn’t all that different from 1976.

Free trade in its fullest incarnation is essential to prosperity. I’ve never understood people who bash other countries. To me, China’s our best friend. China makes some things better than we do, and we make some things better than they do. And we and they would be foolish in the extreme if we didn’t sell them those things we make better than they do in exchange for those things they make better than we do. It’s a win-win for the world. Free trade is extraordinarily important. Seriously, without China there is no Wal-Mart and without Wal-Mart there is no middle or lower class prosperity.

And to bash illegal aliens with the admonition that they should “self-deport” is offensive.

And then let’s take the case of regulations. No one is against regulations, per se. That would be silly. Everyone knows that we as an organized, structured, advanced society have to have regulations. You can’t wake up in the morning and decide which side of the street you’re going to drive on today. But what we need to do is make sure those regulations don’t go beyond the specific purpose at hand and do collateral damage to the overall economy. Regulatory restraint needs to replace regulatory over-reach.

In the not-too-distant future you are going to see a low-rate flat tax, spending restraint, sound money, free trade and regulatory reform. I could not be more optimistic about the long-term future of the U.S. than I am today. And that’s my update to the conference call I had with all of you.

My real purpose for being here today is nothing but concentrated ecstasy for me. I get to introduce the two participants in the next panel discussion. And believe you me, you are in for a special treat. One of the panel discussants is our one and only fearless leader, Tony Batman. Tony truly is the entrepreneur’s entrepreneur. Just look at all of you here and what he’s built in 1st Global and what he’s done as an entrepreneur. He is what the American free enterprise system is all about. He’s amazing. And with his last name of Batman, Tony puts the fictional Batman character to shame. Tony is the real Batman. He’s unbelievably good at what he does and not only that, he’s my new best friend. Tony will be one of the panel participants.

And the other panel participant is George Pratt Shultz. I have known George Shultz for a long, long time in my capacity as one of George’s staffers on numerous occasions. He’s been my boss so many times I can barely breathe. I think he’s the only man in the world who can actually make me shake with fear when he raises his voice. My father could do that as well, but if George Shultz says “ARTHUR!” I just feel this cold chill go down my spine. He’s my mentor, my hero and the man to whom I most look up—my role model. I am going to recount some of my personal times with George Shultz, not as much for your edification but just because it’s fun for me. You all can on your own read about his official exploits.

The first time George Shultz hired me was at the University of Chicago in 1967. I was a graduate student in economics at Stanford University interviewing for a job at the University of Chicago. I thought the University of Chicago’s economics faculty was the greatest on earth. I know this is going to shock you, but I’ll say it anyway—I’m a conservative. The University of Chicago’s economics department wasn’t hiring that year and I was asked if I would be interested in a faculty appointment in the business school. Well, I had no problem with the business school given that I had also received my MBA from Stanford University’s Business School, and so I said I’d love to talk to the University of Chicago Business School. I did the rounds of interviewing at the business school meeting everybody. And then I was awaiting my upcoming meeting with the Dean, who happened to be George Shultz. And just before my scheduled meeting with the Dean I went downstairs—that’s where the men’s room was—and I was standing there in the men’s room and this man came in and stood in the stanchion next to me and said “Who are you?” I said, “I’m Arthur Laffer,” He then said, “What are you doing here?” I said, “I have a meeting in a few minutes with the Dean.” He said, “I’m the Dean. How are you, nice to meet you.” So my first meeting with George Shultz was in the men’s room at the University of Chicago.

I got the job.

Before I actually took up residence at the University of Chicago, though, I took a year’s leave of absence at the Brookings Institution in Washington D.C. and later on Mr. Shultz became Secretary of Labor, so I didn’t get to spend much time with him.

During President Nixon’s first term, the Ash Commission, named after Budget Director Roy Ash, recommended a new government department called the Office of Management and Budget (OMB). George Shultz was named the director of the Office of Management and Budget while he was serving as Secretary of Labor. Not knowing what trouble he was getting himself into, he asked me to be the Chief Economist of the OMB. So I obviously said yes and took the job. The first thing we did was go to Asia on Air Force Two—he and John Ehrlichman and me as the staffer—that was quite an experience.

But one experience that left a lasting impression on me was when I learned that George Shultz is a football freak. He played football for Princeton and was a college hero in football back then. He asked me to accompany him to the Princeton/Yale game in my first year with him at the OMB. And what you should know as well is that I’m a Yalie. The President of Princeton was our host. Even though I’m a Yalie, I never liked football and I never went to a game at Yale (at least not voluntarily) or ever again for that matter. But I went and I sat just there expecting the boring worst while my boss was just loving the game. Princetonians call the Yale/Princeton game “The Game,” but we at Yale don’t call it “The Game.” Our “The Game,” is with Harvard. But Princetonians, bless their souls, take Yale very seriously.

Right at the outset, Yale won the toss and chose to receive. It was Princeton’s opening kickoff and the ball went all the way down five yards into the Yale end zone. The Yale player caught the ball and ran 105 yards for a touchdown—on the opening kickoff no less. And even though I don’t like football, I still am genetically a Yalie and Princeton foe, so I was yelling, “Yay!” and then I looked at George. He was purple with anger, so I [makes a mouth closing motion with hand] was quiet. I know when not to go there. The OMB was great, and George Shultz even greater.

Then, after the OMB, George Shultz was named Secretary of the Treasury. I returned to the University of Chicago, but I stayed on as a consultant to the Secretary of the Treasury—I flew back and forth to Washington two days a week to work with him there. After that, when Reagan was elected, George Shultz was named Chairman of the President’s Economic Policy Advisory Board (PEPAB). He once again asked me to be on that board with him. So for the full eight years of President Reagan I was on the President’s Economic Policy Advisory Board.

Then there’s always Ca-lee-fornia. As Chairman of Governor Schwarzenegger’s Council of Economic Advisers, George asked me to be on that board as well, which I also accepted.

I have known George Shultz in a professional and personal context for a long time, sometimes in circumstances that really weren’t very nice. I’m going to tell you a little bit about the man—you can read his resume, but these personal characteristics you won’t be able to read about.

George Shultz is perhaps the single most ethical man on planet earth. And he is not only ethical for himself, he’s ethical for all of the people around him. I was working under George Shultz in the Nixon White House, if you can imagine, from late 1970 to mid-1972. All of you know the problems that came out of the White House during the period leading up to Nixon’s reelection in 1972. But for those of us who worked for George Shultz we always had the Shultz rules and they were very different from the White House rules. “If it’s worth doing,” George used to say, “it’s worth us paying for it.” We weren’t allowed to fly on company jets around the country like other White House staffers were. And I for one was jealous of what my counterparts were doing. I missed flying around on private corporate jets, but Shultz’s rules were the rules. Well, when Watergate hit and all the problems arose, there was never one inkling of a problem for any person in the OMB, George’s operation. We were as clean as a hound’s tooth.

Totally ethical, as only can come from a principled Marine in World War II, he has a Ph.D. in economics from MIT, Dean of the Business School at the University of Chicago, Secretary of Labor, Director of the Office of Management and Budget, Secretary of the Treasury and then Secretary of State. This man—and I’m going to say this in all seriousness—this man became what he could have been. He really achieved his full potential—his career is just incredible. And it’s not over yet. He’s got another book in page proofs as I speak. My view, and again I know this is going to sound awfully strong, but let me just say that in my opinion, when the history of this last 50 years is written, George Shultz will be the single most esteemed human being having lived on planet earth. Ladies and gentlemen, you’re in for a real treat—our hero Tony Batman and George Shultz. Thank you very much.

SAB: Good morning Secretary Shultz.

GPS: Tony [shakes hands]

SAB: Thank you so very, very much for spending what will be a very profound hour with our wonderful advisors at 1st Global. Let’s have a conversation today about the world, about America, about leadership. I know that you are writing a book right now, and I would guess it’s probably about America’s role in the world, how it was established, and what our role is ongoing now. Can you just talk about how we got to where we are in the world, what the state of the world is, and what America’s role will be?

GPS: I think we’re at a very important moment, and if we play our cards right and do our job right, it can work to our advantage. But that hasn’t happened yet. Let me paint the broad background picture:

At the end of World War II, some gifted statesmen looked back. What did they see? They saw two World Wars. The first one was settled in a vindictive manner that helped lead to the second one. They saw that in the Second World War 70 million people were killed, civilians and military. They saw the Great Depression. They saw the protectionism and the currency competition that helped to aggravate the tensions that led to the war. They saw the Holocaust. The looked back and said, “What a crummy world. And we’re in it whether we like it or not. We’re part of it.” Then they saw the emergence of a very hostile and aggressive Soviet Union. So they designed a whole new set of policies. Instead of a vindictive peace, they helped Germany and Japan reconstruct themselves as democracies and become flourishing economies. They designed a trading system with the General Agreement on Tariffs and Trade that morphed into the World Trade Organization to get a hold on this problem of protectionism and gradually open the world to trade. They designed an exchange rate system that would give some stability and predictability. They emerged with the concept of containment that stood us well throughout the whole Cold War and was the concept on which our actions rested. They designed NATO.

In other words, bit by bit Europe was created. Bit by bit we constructed a global economic and security commons, and it was a brilliant and profound development from which everybody, including the United States, benefited. You had an element of predictability—a kind of broad rule of law that you could operate within. Now we are suddenly in a world awash in change, and that commons is being eroded, and I don’t think we understand it. People aren’t articulating the problem, but we have to articulate it and understand it in order to deal with it and keep that commons alive because the commons is so essential.

Let me tell you the sources of change without belaboring them.

I. First of all, the face of the world is changing radically. In practically all the developed countries, fertility is low, longevity is rising. That affects capability, it affects outlook, and it poses the problem of retirement systems that were put into place some years ago without foreseeing these developments that are now causing huge problems everywhere. You have Germany and Japan’s populations declining. Russia is a demographic basket case.

China has, in some ways, the most interesting demographics because for 25 years with the one-child policy they’ve had a falling young population and a rising labor force. That rising labor force supporting a diminishing number of people—a demographic dividend—is about to reverse, almost like throwing a switch, and suddenly China will have a declining labor force and a rapidly rising number of older people that they have to support. Furthermore, these gigantic gains that they’ve had are the sum of the rise in their labor force plus the rise in the productivity of the labor force. And that productivity rise that has come from the movement of people from rural areas to cities has probably somewhat run its course. But in the meantime people have moved from the traditional Chinese security net of the family into these cities. As they grow older they’re not going to have that traditional support system, or at least a lot of them won’t. So China is heading for some very difficult problems, as I see it.

I should add that in the Middle East and in North Africa, fertility has come down but is still relatively high, and those countries have so organized themselves that young people don’t have much to do. They don’t have jobs.

II. Now, here’s the second thing that has happened: the communication and information revolution. People know about it but I don’t think we comprehend the depth and meaning of these developments. Now people anywhere can find out almost anything of any importance. They can communicate with each other so they can organize, and they start doing things. Remember the Arab Awakening, sparked by an entrepreneur who wanted to start a little business selling fruits and vegetables, but the regime squashed him. Before he set himself on fire, he said, “Why are you doing this to me? I’m just a simple man. All I want to do is work,” but they wouldn’t let him work.

People want to work. Work attaches you to reality. Work gives you dignity. You know that you deserve the pay you receive. So work is important, and as we look at whatever strategies we have in the Middle East, I think we have to say to ourselves, “Until the regimes manage to find their way to an economic arrangement that gives people a chance to work, they’re not going to have stability, because this capability to know and to organize is there and it’s not going away.” But it goes far beyond the Arab world.

Mr. Putin is having all kinds of problems in Russia. There are more protests in China than anywhere else. Anywhere you have autocratic rule you now have this rebellion. In democracies we have it, too, but we’re accustomed, in open societies, to listening to what people have on their minds and trying to do something about it. So, two things have led to this explosion.

III. On to number three and number four. Sovereignty has declined. There are lots of areas in the world where there’s a map; somebody’s drawn a line and put a name on it. But when you go to those places you see there is no sovereign authority; there’s no real government. Of course, those are places where terrorists can go and train and organize themselves. And then you have other places that have a semblance of sovereignty, but it’s hard to say there is sovereign control. Take Pakistan, where you have the civilian government, the military, the intelligence service, and then you have all these terrorist-type groups and independent groups. If you wanted to make a deal in Pakistan, you really wouldn’t know who to make a deal with to be confident that this deal would be carried out. And they have nuclear weapons. In Europe you have ancient nation-states where some of the sovereignty resides in Brussels and more of the sovereignty resides in Frankfurt. So they have given away trade policy and they have given away monetary policy. They want to give away regulatory policy and they’re heading towards tax and spending policy; you don’t have much sovereignty left. One reason they are having so much trouble coming to grips with their problems is that those policies are all mixed up.

IV. Then you have terrorism, and it has caused us no end of trouble. We’re paying a heavy price with two wars. It’s not just taking your shoes off at the airport. It’s a big problem, and we need to think it over much more carefully and have a much more effective way of combating it. I think we are gradually getting better at combating it, but it’s very important that we do so. So, we’ve created a new world; a wonderful world with a reasonably stable global economic and security commons. That commons is eroding. I think it’s very important that we understand why and then start standing up to these reasons and doing something about them so that we can have the benefits of a world that is understandable, has rules, and is not plagued by constant threats of violence.

SAB: Let’s talk about strategy and leadership. It seems that America is receding in its leadership in the world. That is going to leave a lot of chaos, and it takes strategic thinking to solve the new problems in the world. How did you and President Reagan demonstrate leadership to maintain a steady-state world, a prosperous world, and what is needed now? What kind of leadership traits are needed now by America’s political leaders and the world’s political leaders?

GPS: I think you have to have a strategy and not just be tactically responding to this, that, and the other. Let me give you an example that Art Laffer is very familiar with; he was part of it, too. During the campaign we were on President Reagan’s advisory committee on economics. When he was elected he knew, and we all knew, that we wouldn’t have a decent economy if we couldn’t get rid of inflation. Inflation was in the teens, the prime rate was in the twenties, the economy was going nowhere; it was a mess. So President Reagan takes office and Paul Volcker is ready to do what needs to be done at the Fed, namely discipline the money supply. President Reagan puts a political umbrella over Paul Volcker. All the political people were rushing in all the time: “Mr. President, we’re going to have a recession; we’re going to lose seats in the midterm election.” You know what he said? “If not us, who? If not now, when? It’s got to be done.” So we did have a recession; we did lose seats. However, as Art Laffer predicted, by the end of 1982 the incentives began to kick in. Inflation was under control and the economy took off like a bird. But that would never have happened if President Reagan hadn’t had the guts to do strategic thinking and then follow through on it. And the same is true in foreign affairs. The same is true all over the place. You’ve got to have a strategy.

SAB: And the strategy is lacking in your opinion?

GPS: I don’t know whether it’s lacking or not, but I can’t find it. [Laughter]

SAB: Let’s shift gears a little bit and talk about the notion of Star Wars—that had so profound of an impact on America’s international diplomacy—and how you and President Reagan used leadership and force in policies to help with the fall of the USSR—the biggest change in power around the planet in a bloodless way. It is probably the most profound thing that happened in the last hundred years, maybe two hundred years, in world history. How did you do that?

GPS: Well, it wasn’t me; it was President Reagan. Sometimes people asked me about my foreign policy. I always said, “I don’t have one; the President has one. My job is to help him formulate it and carry it out. It’s his foreign policy, not mine.” What you called Star Wars was what he called the Strategic Defense Initiative. Here’s how it came about. He went, before he was President, to a place the Air Force runs in a mountain right around here in Colorado Springs.

SAB: It’s right here, Cheyenne Mountain/NORAD.

GPS: Cheyenne Mountain. I went in there once and it’s just dazzling what they can do. They can see everything everywhere. So after Reagan was dazzled and he was leaving, he said to the general in charge, “General, what would happen if a nuclear weapon hit somewhere near here?” The general said, “It would wipe us out.” Reagan said, “Well, what can we do about it?” The general said, “Nothing.” Reagan didn’t think that was a good answer. We should be figuring out how to do something. And gradually it emerged in his mind—and he sought the recommendations of the Joint Chiefs of Staff, of course—that there was a potential of doing something about it and constructing a defense against ballistic missiles. So he started this program—a research program because we didn’t have any concrete things—but it really got the Soviets’ attention. They probably assumed we knew more than we did, and it was okay to let them think that.

I remember on one occasion there was a proposal where we each agreed to do a lot of cutting of things and in the meantime we agreed not to deploy anything for seven years. I said, “Mr. President, we don’t have anything to deploy in seven years. You’re giving them the sleeves of your vest, and you’re getting something for it.” He loved that; he loved negotiations. Anyway, it turned out to be a great element in the bargaining picture. We never compromised our research program, but we were able to make use of it reasonably effectively, I think.

At any rate, it was the strength that he brought, but also thinking. Here is an example. President Reagan was very strong on the importance of freedom, of human rights. He worried about Soviet Jewry, but he worried about human rights generally, and that was always very prominent in his thinking. One time when I was in the Soviet Union, a man named Shevardnadze, who was my counterpart, said to me, “George, we might do something about some of these things you’re talking about all the time, but only if it helps us, not to please you.” So I got back to Washington and I had twice-a-week private meetings with the President where we just tried out ideas. I said, “Mr. President, here’s what Shevardnadze said, so how about this line of reasoning: We are living in an information age and it is coming on faster than people realize. If you are conducting a society that’s closed and compartmented [as the Soviet system was] you’re going to be left behind. So in your own interest, you need to change the nature of the relationship of the state to the human being. Let people communicate, let people migrate, let people get around more.” And we both agreed that idea was a good thing. So I wrote out and I went over very carefully with him the statement I would make. Then in one of my meetings with Shevardnadze I read the statement. I read it very slowly so their note-takers could take it down exactly right. Later I learned that it did emerge in a Politburo discussion, and Ronald Reagan took it to students at Moscow State University when he spoke to them at the Moscow Summit. I was sitting where I could see their faces, and I’m sure they all had been told to come and listen to this guy. The President started talking to them and I could see their faces starting to change, saying, “He’s talking about us and our freedoms and our future.”

So we used strategic thinking to develop a different point of view, and, in the end, we had a massive immigration of Soviet Jewry. We had a big change, and it wasn’t just for pounding away on what you call Star Wars or our basic defense structure but also some fairly deep strategic thinking. We found counterparts with whom you could have a conversation in Gorbachev and Shevardnadze, and that was important.

SAB: Along that same line of leadership, Ronald Reagan knew how to build teams, but he also had a knack for going across the aisle. How did he do that? What was the style? How did he embrace opposite ideologies to come to a common ground which seems to be missing so much today in political discourse?

GPS: Well, first of all, Ronald Reagan was fun. If you were going to have a session with him, you looked forward to it because he liked to tell stories. He was a wonderful storyteller. If you looked at his phone log and meeting log on any week, you’d see it was full of phone conversations with members of Congress of both parties. He used the White House theater a lot, gave parties and so on. He was gregarious. Somebody asked about Tip O’Neill (Tip was the big Democratic leader), “Is he your adversary?” Reagan said, “Not after five o’clock!” [laughter] That’s when those guys got together and cut their deals.

Here’s an example of an attitude towards something. President Reagan proposed what became in the end the biggest tax change (Art Laffer loved it): the 1986 Tax Act, where preferences were cleaned out and the marginal rate went down. Incidentally, when President Reagan took office, the marginal rate was 70, and it went down to 50. When he left office it was 28. That tells you something. And employment was going strong; the economy was going great. The Laffer Curve—there it is. Evidence. Anyway, he proposed what became the 1986 Tax Act. It worked its way along with lots of back-and-forth with members of Congress explaining why this was a good thing. It got scored eventually by the staff of the Joint Committee on Taxation, which was then, and I suppose is now, highly respected, so people accepted their scoring. They scored on a revenue-neutral basis. Of course we all knew that if it got enacted that there would be a dynamic response. And in the end it got introduced in the House by Dick Gephardt, the Democratic leader, and in the Senate by Bill Bradley, a Democratic leader. It passed the Senate 97 to 3. Somebody asked Ronald Reagan if it bothered him that two Democrats helped introduce this legislation. You know what he said? “It passed, didn’t it?” That’s called governance. President Reagan did that kind of thing all the time.

SAB: Let’s shift gears and talk about the domestic economy. How do you compare our current fiscal cliff in 2012 to the fiscal cliff that you had in 1981 and 1982, and what proposals do you see about the current fiscal problem? What solutions do you see? The Simpson-Bowles solution? Compare these two points in history; what you were thinking back then, what you’re thinking now, and what could be a possible solution for our fiscal calamity.

GPS: Back then we made a written report to President-elect Reagan between the election and when he was inaugurated, and I’d be glad to make it available to you all. The Wall Street Journal printed quite a bit of it recently, but we just codified things he’d said in the campaign and made a proposal out of it. Obviously, he would get tax rates down, he would get spending under control, and get the regulatory process under control. We were big on that. Amazingly there still were the remnants of the wage-and-price control system from President Nixon. So, on his third day in office he abolished the remnants of that system, and that was a big signal. It was decisive and it was strategic.

What would I do now if I could have my way? Well, I don’t think it’s unrealistic to think that there could be a redo of the 1986 Tax Act, and, personally, I don’t think it would take forever because the template is there. The record of 97 to 3 is there. The Joint Committee staff could score it overnight. It’s not a mystery how much you save taking these preferences out. And if you did something like that you would take the Bush tax cut problem away because you would substitute a new personal income tax system. I think that would be doable. In fact, John Boehner, in the very forthcoming statement that he put forward right after the election, more or less proposed it and said, “Okay, let’s do this and let’s score it in such a way that we can be sure, Mr. President, that you get more tax revenue. This will produce more tax revenue if you could just distinguish between revenue and rates for a minute. Isn’t it revenue that you want? Or is it just that you want to punish people?” So let’s stop punishing people and start rewarding people and have tax revenues. That’s really the objective. So I think that’s a possibility.

I also think that it is almost universally recognized that the corporate tax rate is too high. Obama has said that. It’s obvious. So you could do a little bit of the same thing—eliminate preferences—but it wouldn’t get you as far as you need to get. The corporate rate ought to come down at least to 25 percent—personally, I would prefer it to be a little lower—and leave the capital gains tax rate and the dividend rate alone. I don’t know whether those things are conceivable.

If Ronald Reagan were there, I’ll tell you what he’d do. He’d get all the relevant people together and say, “Let’s start a conversation. What’s our first topic?” The first topic is: Where are we trying to go? What are we trying to achieve? Well, we want prosperity without inflation. Isn’t that our goal? What contributes to that? How do you avoid inflation? Shoot the Federal Reserve, that’s the first thing! [laughter] Honest to goodness, what they have piled up in terms of the monetary base [is worrying]. Art Laffer publishes wonderful material—I’m sure you get it—and Art has developed the ability to graph things so that you see this gigantic buildup of reserves. Incidentally, the Fed, in the way it conducts itself now, gives money to banks—you heard me say that—and when interest rates go up it’s going to be more. Now where is there an authorization for that organization of government to give money to banks? It’s not there. I think there’s a lot of work to be done to clean up the act.

Then we have to get the regulatory business under control. People have studied regulation. A good friend of mine and Art’s, the late George Stigler, at the University of Chicago and a Hoover fellow, coined the word “regulatory capture.” It’s generally what happens when you have this looking-over-your-shoulder-all–the-time form of regulation. I think we have to find our way to simpler, easier-to-spot regulation that puts the interests of the person being regulated in line with the object of the regulation. Here’s an example in the field of nuclear power:

All the people operating nuclear power plants realize that if something goes wrong in any one of them, it’s devastating for all of them. So they have developed a system where they go around to each other’s plants—the operators who know what works and what doesn’t work and what the safety issues are—and they inspect each other’s plants. They don’t make written reports, but they tell each other in no uncertain terms to “do this” and “do that.” This has produced a really good safety record here. So we have got to align. The first thing I think is that bonding is a pretty good way of doing it. But this business of hugely complicated regulations that nobody can even understand. I don’t think is the way to go; it just ties things in knots.

SAB: Well I believe President Reagan in 1981 had a new agency called OIRA that scored regulations before they could be passed on to the House or the Senate to determine their impact on commerce. Where is that agency? Is it defunct? It was a very good agency. It did monumental work in curbing unnecessary regulation. Let’s get even more granular.

GPS: Well, we have to start with the fact that regulation is needed, but you have got to have it sensible and workable. Obviously, the regulation of the financial community didn’t work. The regulators had people in all the banks all over the place, but it didn’t work. And when the president of Citicorp gets up and says, “As long as the music is playing you’ve got to get up and dance,” if you’re a regulator you’ve got to say, “Come on, we’d better look at this.” But they didn’t.

SAB: Two areas where you have much interest these days are in energy policy, and the other might be drug policy. Let’s talk about energy policy. What is some of the work you are doing at the Hoover Institution, and where might this country be headed toward inexpensive self-sufficient energy?

GPS: Well I think this is one of the places where we have a big opportunity and where, in a sense, you can start building that economic and security commons because here the opportunities all derive from innovations. We have this technology that has gradually emerged called fracking. We have learned how to drill down and then horizontally. Then people have learned how to pressurize what goes horizontally and open up the seams of oil and gas and be able to extract them in ways that were thought earlier not to be possible. The result is that in this country we have suddenly seen a huge increase in our reserves of natural gas and the production of natural gas and the price has gone down—prices always fluctuate—but there is a new kid on the block named fracking. And it is also applicable to so-called tight oil. In North Dakota and South Texas, crude oil has been produced in huge amounts, and for the first time in three decades the amount of crude being produced in the U.S. is going up. So we have to see to it that these techniques are used carefully to deal with the methane problem, which can be a problem and to deal with contaminated water. I’ve been assured by people who know something—I don’t pretend that I’m an expert—like the Environmental Defense Fund that there are ways of dealing with this. You just have to do them right.

Now this can spread around the world. For instance, I was in China with a small group that Henry Kissinger organized last January. Among other things, we had a meeting with the man who will become Premier. I mentioned the fracking technique and that I was interested. He knew a lot about fracking and he was looking for ways to learn more. Then he said, “Here are six places in China where we could probably use this technique.” So what that means is that the geopolitical map of energy can be changed, and the proportion of natural gas in the supply chain will rise. Natural gas is much more benign from a carbon standpoint than either oil or certainly than coal. So this is a big plus on the environmental side.

Now let me go back and say that I think the three things we need to pay attention to on energy all the time are: our national security, our economy, and our environment. In national security terms, we are seeing our way to a more secure supply. But I think we also have to learn how to produce energy where we use it to a much greater extent. We’ve all seen reports of supply trucks being blown up in Afghanistan. I’m a Marine so I follow the Marines. They have a gadget they carry around that is not much bigger than a piece of paper. You flip it open and there are 12 solar panels. So they can minimize what they’re carrying in their backpacks, and they have energy created where they use it.

I have a friend who is a commander in the Navy. He says, “I’m a flyer. Every flyer knows you can go down. I’ve flown a lot of missions in Afghanistan. If I go down, I pull out this gadget [he carries it all the time] and I turn it on. My friends know where I am. The only problem is it only lasts 48 hours.” He pulls out another little solar device and he can recharge it—energy produced where you use it. Now our grid that we rely on is very vulnerable to cyber attacks, let alone other things, so I think we need to learn how to produce energy near where we use it.

So on one hand we have the oil and gas opening with fracking. We also have, much more than ever before, a fairly significant amount of high-powered people—scientists and engineers—studying alternative methods of producing energy, how to use energy more effectively, and so on. I chair energy committees at Stanford and at MIT, so I listen to these cats come and talk about what they’re doing. Solar energy and solar panel prices are about down to where they compete with the grid. You talk to the scientists involved and they’ve got a jillion ideas about efficiency. Furthermore, half the cost is installation, pick and shovel work, so I said to them, “Can’t you design a panel that’s easier to install?” So I think we’re really getting somewhere in that regard.

Then there are people working on large-scale storage, not just batteries (batteries, I might say, are being improved all the time) but large-scale storage. Now, large-scale storage helps you with having energy where you use it, but it also helps with the intermittency problem of solar and wind.

Then you have fuel cells. There’s a company in Silicon Valley named Bloom Energy, and they have units about the size of a pickup truck that are filled with fuel cells they’ve invented made from ordinary sand, so there’s plenty of that. Right now, they can put natural gas over it with their computer program and produce a lot of electricity. So that can be energy produced where you use it. I keep telling them to try hydrogen, and the scientists are gradually figuring out how to get hydrogen out of water less expensively. Once you can really do that well you can put hydrogen over those fuel cells and not only get electricity, and it’s absolutely clean, but you also get potable water, which in many areas of the world is important.

I have a little personal experiment going on. On the roof of my house on the Stanford campus I have solar panels that have been there about five years. If I were installing them today they’d be better but, anyway, they’re there. By this time I’ve saved enough on my electricity bill to pay for the panels. In another year, Dr. Laffer, I will have paid for the opportunity cost of the money I lost. [laughter] And I’m driving an electric car. So I say that I’m driving on sunshine—there’s plenty of it in California. Take that, Ahmadinejad! [laughter] But, anyway, I think there are big prospects.

Always in the past, whenever we’ve had breakthroughs in the price of crude or whatever, interest goes away on this research. This time it’s got to be different; we’ve got to keep the research going. And my own opinion is that the government should stay out of commercial operation. When they get involved and then they have some catastrophe like Solyndra, they set back the whole thing. Stick to the R & D. I’m encouraged that at both Stanford and MIT over half of our funding comes from private industry, and they’re energy companies or energy-using companies. Some people in universities shudder at those funding sources, but Stanford and MIT both like it because we figure that if somebody has a really good idea, these are the guys who would know how to commercialize those ideas and put them out and scale them up. So I think this research is something that needs to be kept going, and when it does we will change the energy picture from the standpoint of our security, we will change it from the standpoint of our economy, and we will also be in the process of producing cleaner energy and less CO2 emissions, and that will be good.

SAB: Let’s talk about drug policy—kind of a different shift. You first proposed perhaps three decades ago that drugs should be legalized, not just decriminalized but perhaps legalized. Colorado and Washington State in this last election both legalized marijuana. I think there’s a growing consensus in America that this makes sense. We just need to study alcohol Prohibition and see that we’re repeating some of the same cycles there. I know that this can be controversial, but I think America is probably ready for this conversation.

GPS: When I make a statement like that I find that nobody wants to come near me. They don’t want to get their picture taken anywhere near where I am. I made a statement after I left the office of Secretary of State. I was making a casual speech to some alumni group at Stanford and it wound up in The Wall Street Journal. I was saying that we had to change our approach. I was inundated with letters, and 99 percent said, “I agree with you.” And of those 99 percent, almost all said, “…but I would never say that in public.” It’s a taboo subject. So I think the first thing we have to do is to be willing to have an open debate and to be willing to look at evidence.

Now, way back when I was director of the budget, one of my colleagues was Pat Moynihan—the late Pat Moynihan, later Senator Moynihan. He was a counselor in the White House. He was kind of an unofficial drug czar, and the method was to keep drugs out of the United States; that’s the way you would prevent them from being used. We are riding up to Camp David where I am going to make a presentation. I’m studying my notes and trying to get it right, and Pat’s in a state of euphoria. And that Irishman in a state of euphoria was something else. He said, “Shultz, Shultz, you realize we’ve just had the biggest drug bust in history?” I said, “Good work.” He said, “Yeah, but this was in Marseilles. We’ve broken the French connection.” I said, “That’s great.” There was a pause, and he said, “Shultz, I suppose you think that as long as there is a big profitable demand for drugs in the United States there will be a supply.” I looked at him and said, “Moynihan, there’s hope for you.” [laughter]

Drugs are easily available. Ask your grandchildren. So the tactic of keeping them out has not worked. That’s clear. In terms of use, the United States is on the high end compared with other countries. So I think you have to say the war on drugs is a failure. We’ve created a gigantic bureaucracy. Nobel laureate Gary Becker and his colleagues have estimated over $100 billion a year in just the prison costs and so on. If you add on the costs in Mexico and Guatemala—Mexico has had over 50,000 people killed in the last five years in the drug war and Guatemala is even worse—and all that they expend, let alone the cost of human lives, it’s probably a quarter of a trillion dollars a year we’re spending on this. And for what? We’re not getting anything. We’re getting more people in jail, more ruined lives. So what can we do?

My thinking has shifted as I’ve learned more, and I’m very interested in what’s been going on in Portugal. They’re a transit country—drugs are coming into Europe through them from Africa—and they recognized they had a big problem. They maintained illegality but they decriminalized use and small-scale possession—in other words, possession on a scale that would be for personal use, and they created treatment centers. If people don’t fear arrest for admitting they’re taking drugs, they are more willing to go to a treatment center and get some help. And there has been no explosion in use, as some people predicted. The system really hasn’t made much of a dent on older addicts, but with people under 20 or so there’s been a substantial effect, and that’s really important. Furthermore, the jails have emptied out in the sense that they’re not full of the drug people, and it’s had a noticeable effect on HIV/AIDS—there is now much less of that problem. So I think they’re on the right track.

It’s interesting that the South Americans are so upset about this. It’s almost as though we have become the enemy of South America in the sense that the huge profits from illegal drugs in the United States are fueling drug people in their countries and making it hard to govern. So we’re responsible for the difficulty of governance in these countries, and they are reacting very negatively. We should do something about it. I wrote a piece with Paul Volcker in The Wall Street Journal giving our views but ended it by saying that at least we should be willing to have a debate and to look at evidence and understand it. Personally, I think we can do a lot better, but I know that nobody in this room will be willing to have their picture taken with me, having said that. Maybe you [Tony].

SAB: You were the Dean at the Graduate Business School at the University of Chicago up until 1969 and then you went to work for the Nixon White House. You had Milton Friedman also at the University of Chicago. What is your notion of the state of academic work in economics, and can you tell us a vignette about Milton Friedman, who has so inspired us as free-marketers? What is the state of academia in economics?

GPS: Well, economics continues to flourish. It’s a very popular major in most universities—certainly it is at Stanford. There’s a lot of good research going on in economic policy. I don’t know that anybody’s really improved on Milton, and Art Laffer was one of Milton’s associates and students, but Milton was just something else. We all sit around—I wish he were around—and I wonder what he would think about this or that, and we sort of know, but he was sensational. He was really the smartest guy in the room although he didn’t push it in your face. And he could theorize with the best of them. But Milton believed deeply in the importance of reality, of facts. So his empirical work on consumption and on money is just massive, and that’s basically where he won his Nobel Prize. He thought that if you had a theory and you couldn’t test it with facts then it wasn’t any good as a theory; it had to be testable. He believed in the facts. So on his birthday I sang him this song, which you will probably recognize:

A fact without a theory is like a ship without a sail,
is like a boat without a rudder,
is like a kite without a tail.
A fact without a theory is as sad as sad can be,
but if there’s one thing worse,
in this universe,
it’s a theory, I said a theory, I mean a theory
without a fact!

[applause]

SAB: Oh my gosh. Mr. Secretary, I just have one question remaining. And that would be your hopes for America. We’ve got problems. To some they seem insurmountable. I like your notion that we have the political will to solve our nation’s fiscal problems, get the monetary house in order, that we can reestablish ourself in the world as a leader that creates world prosperity.

GPS: Well, I think the answer to all those questions is yes. I think we know how. We’ve been there before. We’ve been down, we’ve gotten back up again. We can do it. We have the resources. We have to figure out better how to take advantage of those resources. But let me just remind you—going back to Ronald Reagan—of a very poignant letter that he wrote us. About ten years before he died he learned that he had Alzheimer’s disease, so he wrote to us—his beloved American people—a wonderful letter. And the last two sentences of that letter said, “I now begin the journey that will lead me into the sunset of my life. I know that for America there will always be a bright dawn ahead.” I agree with Ronald Reagan.

SAB: Thank you, Secretary Shultz. Thank you so very much.

 

[3] George P. Shultz and Paul A. Volcker, “A Real Debate About Drug Policy,” The Wall Street Journal, June 11, 2011.

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